Putting Gold and Gold Stocks in Proper Context

The precious metals complex had a great rebound at the end of the summer but
is now in the midst of a correction. Recently we wrote that the correction
was nearing an end. We believe that to be the case. A short-term bottom could
occur sometime this week. However, the precious metals sector was unable to
retain much of the very strong momentum it previously had. Thus, the metals
and stocks will need some time to confirm support and generate positive momentum
before they have a chance of breaking to new highs. That being said, we wanted
to take a broader view and analyze the sector in its current context in comparsion
to the past.

Gold is likely to end up in its longest consolidation, which would surpass
the 2006-2007 and 2008-2009 consolidations. Note the chart below and our observations
on the three consolidations. Gold's current position is weaker than the previous
two consolidations but that won't be of concern as long as the metal holds
above the 400-day moving average at $1650. Whether Gold holds at $1650 or
bottoms at $1600, the metal is likely to remain in this consolidation for
a while.

Checking the gold stocks (HUI), we see that the 400-day moving average provides
excellent context. The gold stocks put in a strong double bottom and rallied
up to the moving average. The market is now correcting the previous overbought
state. In the three previous examples, the market began its rebound off of
a major bottom (2000, 2005, 2008) and encountered initial resistance at the
400-day moving average.

We focus on 2005 and 2008 because those are most applicable to today's situation.
In 2005, the HUI traded around the moving average for almost three months
before pushing up to the previous all-time high. A similar thing happened
in 2009. The HUI wrestled with the 400-day moving average from May until September
before eventually rallying back to all-time high.

To conclude, there is nothing to be worried about in regards to precious metals.
First, we should note that the shares have been showing more strength than
the metals, which is always a very good sign for the near future. Second,
the metals and more specifically the shares have been acting exactly as they
did within a similar context in the past. After a rebound from a major low,
the shares typically correct and wrestle with the 400-day moving average before
embarking on a move to previous highs. Traders and investors are urged to
be patient and accumulate at support when sentiment is constructive. Now while
the market is wrestling with the 400-day moving average is the time to do
your research and find the companies that will lead the next leg higher and
outperform the market indices like the HUI, GDX and GDXJ.

Good Luck!

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